Team 7 April 23, 2012 ACC 232 Financial Analysis Project: McDonald’s vs. YUM! Brands The American economy is a free-­‐market, private enterprise system that has government intervention limited to areas like health care, transportation, and retirement. American companies are among the most productive and competitive in the world. Though the recent recession (Dec 2007-­‐ June 2009) had a major effect on the economy of the country, more recent data has shown positive development. The Gross Domestic Product (GDP), which is the output of goods and services produced by labor and property located in the United States, is a very good indicator of the economic condition of a country. The GDP had been declining in 2008 and 2009 due to the recession, by -­‐0.3 and -­‐3.5 percent respectively. However, in 2010 GDP had gone up by 3.0 percent and another 3.0 percent in 2011. The greatest contribution to the increase in real GDP for 2010 and 2011, among the services producing sector and goods-­‐producing sector, was by the goods-­‐producing sector grew 5.6 percent after having two consecutive years of decline (U.S. Economy at a Glance). The Consumer Price Index of food-­‐away-­‐from-­‐home in 2011 inflated at a rate of 3 percent to 4 percent, which means that the prices paid by urban consumers for food away from home have increased on average over time. According to the Bureau of Labor Statistics, the total productivity (defined as output per hour) of food services and drinking places has increased 1.9 percent in 2010, which is encouraging for the industry (Productivity and Costs by Industry). Although the economy has had its ups and downs over the past few years, the dining industry as a whole has managed to remain prosperous. Though many small companies have failed, the well-­‐established companies have used their good standings to help them stay in business and continuously increase their sales and revenue. The total number of restaurants nationwide remained stagnant at 945,000 from 2007 to 2010, while generating sales of $580 billion in 2010, which is almost a 3 percent increase from the previous year. Analyzing these numbers, we can tell that the recession did not allow new companies to form, but that the customers continually purchased fast food from the large well-­‐known companies because their products were inexpensive and trustworthy. Specifically, fast-­‐food restaurants have also been able to increase revenues over the past decade, with the average annual revenue being $717,000 in 2007, compared to the $671,000 average in 2004. It is also apparent that over the past fifty years, eating out at restaurants has become immensely popular amongst the American population. In the mid 1900’s, 25 percent of the average American’s money allocated for food was used to eat out, now the number has risen to 45 percent. In summation, the restaurant industry in terms of full service and fast food is generating more profits each year and is continuously growing. After discussing the economy and how it is affecting the dining industry we will look more in depth into two different companies. The McDonald’s corporation began in 1940 with a single location and by 1955 Ray Kroc opened the first franchised McDonald’s. At the end of 2011 the McDonald’s corporation had drastically expanded and is now located in 119 nations. Throughout these nations there are 33,510 restaurants currently open (“McDonald’s”). As a result of the thousands of restaurants operating, the corporation as a whole brought $27,006,000,000 in revenue during the year of 2011. This is an increase from the 2010 revenue of $24,074,600,000. Due to the 33,510 restaurants that are currently open, there are approximately 420,000 people employed around the world by the McDonald’s corporation. By the month of April 2011, the McDonald’s corporation had hired approximately 62,000 people in the United States alone (Patton). To put that number in perspective, later that year there were only 150,000 jobs created throughout the entire United States (Casselman). The recent success that McDonald’s has been experiencing through an increase in revenue and stock price is a result of their “Plan To Win” strategy. This business plan was introduced in 2003, when their stock was trading at $13, and has now successfully driven their stock prices up to as high as $98 today (CBS). Their plan utilizes the people, products, place, promotion, and price. They will continue to use this plan to stay relevant and trustworthy to their customers. The “Plan to Win” business strategy was introduced by a group of executives including the current CEO, Jim Skinner, who plans to retire near the end of 2012. Even with Skinner’s retirement from the company coming at the end of June 2012, McDonald’s will continue to use this strategy to succeed in the current and future world market. YUM! Brands Incorporated was founded in North Carolina in 1997, but was originally called TRICON Global Restaurants Incorporated until May 16, 2002. Yum! Brands has over 466,000 employees working in approximately 37,000 restaurants in 120 different countries. YUM! has five separate operating segments, which include: YUM! Restaurants China, YUM! Restaurants International, Taco Bell, Pizza Hut, and KFC. The China Division is based in Shanghai, which consists of 4,500 restaurants that generate revenues of $5.6 billion and Operating Profits of $908 million. The International Division is stationed in Dallas, Texas, consisting of 14,500 restaurants generating $3.3 billion in revenues and $673 million in Operating Profits during the year 2011. Since YUM’s primary focus in the food business is Mexican-­‐style food, chicken, and pizza, the majority of YUM’s restaurants fall primarily with Taco Bell, Pizza Hut, and KFC. Taco Bell was founded in Downey, California in 1962 and has grown to 5,670 units in the United States and 275 internationally. Pizza Hut first began business in Wichita, Kansas in 1958, and less than a year it opened its first franchise. Pizza Hut currently has 764 units in China, 5,383 internationally, and 7,600 units in the United States. The first franchise of KFC was opened in 1952 in Kentucky, and eventually became more popular than the previous two restaurants. KFC operates in 115 different countries with 3,701 units in China, 8,920 units internationally, and 4,780 in the United States. YUM! Brands Inc. is a speedy service restaurant company that creates, operates, franchises, and licenses these restaurants. With the recent recession directly affecting customer’s dining budgets, inexpensive fast food restaurants like McDonald’s and those included in YUM! Brands become increasingly appealing for financial reasons. Therefore, both companies had the opportunity for growth during the recession. Although YUM! Brands was not founded until 1997, almost sixty years after McDonald’s, their growth was not poorly affected by being a “new company” because the restaurants established within YUM! Brands such as Pizza Hut and KFC have been around since the early fifties and sixties. Since both companies are “playing for the same team” in the economy, one can estimate that they will be equally influenced by the recession and the current expansion. Taking a closer look at the individual companies, it is interesting to see that despite YUM! Brands having roughly 3,500 more restaurants than McDonald’s, McDonald’s still managed to produce more than twice as much revenue as YUM! Brands in the year of 2011. Both companies are located in 119 to 120 different nations, so the location must not be the variable creating the difference in revenue. McDonald’s may be having more profitability success due to their well-­‐known, long standing reputation which can work to their advantage in attracting customers. While YUM! Brands may be struggling to develop a solid reputation, since they include a variety of un-­‐related restaurants. Considering each company’s future potential, one can calculate the growth rate of the net revenue from year to year. YUM! Brands increases at a growth rate of roughly 4.6 percent from 2009-­‐2010 and then 11.3 percent from 2010-­‐2011. YUM! Brands growth rate was doubling from year to year. McDonald’s growth rate increased similarly, but slightly less drastic. Their growth rate from 2009 to 2010 was 5.8 percent and from 2010 to 2011, they grew at a rate of 12.1 percent, which is slightly less than double. One might predict that while YUM! Brands revenues are currently sitting below McDonalds’, they may be growing at an increasingly quicker rate and may be able to eventually catch up to McDonald’s yearly revenue. Taking a deeper look into the YUM! Brands financial statements and calculating the liquidity ratios, one can see that the current ratio over the past six years averages to 0.73, which means that the company is not fully able to cover its current liabilities with its current assets. However, YUM! Brands being relatively new in comparison to McDonald’s, has a relatively large portion of its current liabilities as a percentage of total assets, about 27.73 percent. Although the current ratio of YUM! Brands is 0.95 and is smaller than that of McDonalds, which is 1.25, it is consistent with the industry average. Furthermore, it has increased from 0.73 to 0.95 over the past two years. The quick ratio over the past three years averages to 0.55, which is much less than McDonald’s but consistent with the industry average that is 0.5. Just like the current ratio, the quick ratio has increased immensely from 0.36 in 2009 to 0.61 in 2011. Looking closely at the components in the ratios that include current liabilities, current assets, cash and accounts receivables, we can see that current liabilities has increased minimally over the past years. Although the current liabilities have barely increased, YUM! Brands current assets have increased substantially, making the current and the quick ratio go up. With a closer observation we can see that the main reason behind these increases is the increase in cash, which was $353 million in 2009 and $1198 million in 2011. The increase in cash is primarily due to the increase in sales, which increased by a $1790 million between 2000 and 2011. This drastic increase in sales is primarily due to the great success of YUM Brands, especially KFC, in China. Investors might look upon the company’s Days payable outstanding, which is 28 and which indicates the number of days required to pay suppliers and vendors, with some distaste because the industry average is 15. Looking at the positives in liquidity, the company’s average days to sell inventory is 9 and is in unison with the industry average of 8. Though the average collection period is substantially higher at 8 days compared to the industry average of 0, it is not necessarily a bad thing. The company is actually in a positive situation, because it collects from its customers 20 days faster than it pays its suppliers. It also has a comparative advantage over its competitor McDonald’s, whose average collection period is 17 days. YUM! Brands is performing well in the profitability section. Net profit, which is total expenses subtracted from total revenue, rose significantly by $157 million between 2010 and 2011. The net profit margin, which was 10.57% in 2011, is also strong and has been increasing steadily over the past three years. Although McDonald’s has significantly higher net profit and net profit margin, $557 million increase between 2010 and 2011 and 20.38% respectively, we have to remind ourselves that McDonalds is relatively a very old company. In fact, McDonalds is 57 years older than YUM! Brands. The fact that YUM! Brands is retaining a solid net profit margin and is increasing the net profit at the same time gives the company two very positive options. It can retain these earnings to produce higher profits in the future by investing in areas of important growth, like expanding in developing economies, or it can distribute the earnings to shareholders. Both of these improvements will tend to benefit the shareholders. There is one small issue though to be pointed out in this area, the net sales are rising quickly and were $1283 million between 2010 and 2011. This is not normally an issue, but the net profit has only increased by a $157 million and the net profit margin has stayed relatively the same. There has only been a 0.59 percent increase since 2009. This means that the company’s operating costs are increasing. The net total costs and expenses increased by $1237 million from 2010 to 2011 and the major contributor to this increase was the food and paper expense that increased by $542 million in two years. But, this increase in operating costs might not be limited to YUM! Brands alone, many companies have been reeling under the pressure with increasing commodity inflation and increasing food costs. The inflation for food and labor is expected to increase and this might be the reason why the company is eager to reduce the ownership of restaurants by refranchising them, following the low-­‐risk strategy. YUM! Brands’ debt ratio, proportion of a company’s debt relative to its assets has been declining over the past three years. It fell from 84.42 percent in 2009 to 78.31 percent in 2011. On the other hand the company’s net profit margin, which is net profit represented as a percentage of revenue has been increasing from 9.99 percent in 2009 to 10.57 percent in 2011. This is a very good situation to maintain as long as possible. This shows that the company may not need to increase debt to continue to improve net profitability at this time, which is positive. In this case, we can clearly see that the company was able to improve profitability without borrowing money. Not only is the company able to generate profits without taking on huge debts, it is able to do so without any significant addition of fixed assets. In other words, the company did not make any significant fixed asset additions, but still improved profitability. While the fixed assets increased by $143 million between 2009 and 2011, the most liquid asset-­‐cash-­‐ increased by $845 million between 2009 and 2011. This shows that the company is using its assets more efficiently than before to generate revenue. One of the major positive points, which provides YUM! Brands with a comparative advantage over its competitor McDonalds, includes the return on equity that the company earned this period. Though the return on assets ratios for both companies have been almost equal, the return on equity for YUM! Brands in 2011 was 74.48 percent in 2011. This can be interpreted by saying that for every $1 invested in stockholder’s equity, the company generated $74.48 of net income. This is much greater than McDonalds 37.92 percent($37.92 of net income, for every $1 invested in equity). This huge difference can be owed to fact that YUM! Brands’ net income, which is 69.67 percent of its total equity, is relatively more than McDonald’s net income, which is 38.24 percent of its equity. The fact that profits are moving positively against assets and the company is generating good returns on investments and assets, is a very positive phenomenon for the company as well as for the investors. After analyzing certain ratios of YUM! Brands, one can look at similar ratios of McDonald’s to explain their profitability, efficiency, and solvency. The company’s net profit rose approximately $557 million during the year of 2011, and was on the rise the previous years as well. Both the net and gross profit margins have been stable over the past three years, barely moving a full percent overall. There is something to be noted by the fact that the net sales has increased by $3 billion but as we previously stated their net income has only increased $557 million during the same year. The inflation of food can be the source of the increase in expenses that is chopping down their net income. They only gained $200 million in profit off the extra $1 billion increase in sales compared to the previous year. Looking at the increase in their Return on Assets shows us that McDonald’s is growing steadily and is more efficient in managing their assets and is generating revenue. The net profit margin is driving the Return on Assets, which is calculated by taking the net profit margin of 20.38 percent and multiplying it by the total asset turnover ratio of .88. The company’s return on equity increased 3.5 percent from 2010 to 2011. The growth of the two ratios over the past few years symbolizes McDonald’s ability to generate revenue efficiently in comparison to the value of their Equity and Assets. Though McDonald’s total amount of Shareholder’s Equity underwent a slight decrease between 2010 and 2011 due to a repurchase of treasury stock, their Net Income continues to get larger every year, with a significant 11.3 percent increase from 2010 to 2011. Efficiency is another area where McDonald’s also performs strongly and is shown by their ability to have an inventory turnover ratio in 2011 of 143.97. This is over three times higher than the industry average of 43.6. It is clear that McDonald’s is easily and frequently able to dispose its inventory in comparison to other similar restaurants. That means their inventory sits on the shelves for an average of 3 days, compared to YUM! Brands at 9 and the industry average sitting at 8. McDonald’s is able to move its inventory several times faster than their competition and keep their efficiency at a stable rate. To be able to maintain and finance this efficiency, McDonald’s uses a business model that heavily relies on long-­‐
term debt. They also attempt to utilize resources in a manner that allows for future expansion and growth of the company efficiently. McDonald’s has continued to show strength through this recession and will continue operate as efficiently as possible. McDonald’s holds a Current Ratio of 1.25; this is a decline from 2010’s ratio of 1.49. It seems that the reason for this decrease is not due to a related decrease in Total Current Assets, but rather an increase in Total Current Liabilities. The rise in Current Liabilities is most likely the cause of an increase in the amount of current maturities of long-­‐term debt due during the year of 2011. The Quick ratio also shows the same results, a slight decrease between 2010 and 2011. Even though these two ratios seem to extinguish McDonald’s overall performance, it appears that McDonald’s will be able to easily cover their debt while at the same time maintaining their strong profitability. McDonald’s financial leverage ratio of 2.26 can bolster this statement, by showing a higher number than the previous year’s. This is the result of successful employment of debt in the current business model, as well as the result of repurchasing a large amount of treasury stock lowering the stockholder’s equity. To take out the impact of stock purchasing programs on the company’s solvency we can take a look at the debt ratio. It has been increasing over the past two years and is now settling at 56.38 percent. This means that over half of McDonald’s assets have been financed with debt, which is not surprising when we take into consideration their financing policy. This is much lower than YUM brands debt ratio but McDonald’s uses relatively more stockholder’s equity to finance their operations. In terms of marketability, it seems that McDonald’s certainly has a much stronger record and even appears to be improving. Their earnings per share as of 2011 was 5.33 and shows an increase of 27.8 percent over the last two years. Meanwhile, YUM’s earnings per share the same year was 2.81, they only increased by 18.9 percent over the last two years. These statistics are not out of the ordinary when comparing a powerhouse company like McDonald’s to a number of companies within it’s industry, especially with McDonald’s massive treasury stock repurchases. However, when taking a look at the Price/Earnings ratio it seems that one of these companies are either over or under priced. For the Fiscal Year of 2011, McDonald’s ended the year with an 18.82 P/E ratio, while YUM brands closed out with a P/E ratio of 21.00. Due to the lower amount of income that YUM’s is generating on each dollar of equity, it seems as though investors are paying more than necessary for shares. Though the Dividend Yield ratio for both companies has decreased over the past three years, with McDonald’s showing the more significant of the increases, this is only relevant to the closing price of their common stock. McDonald’s has still managed to increase their amount of dividends paid to shareholders every year since the business was started. It is apparent that in the category of marketability McDonald’s proves to be the slightly more dominant candidate for an investment. As far as investors are concerned, the two companies appear to be extremely similar in their appealing profitability growth. While both companies have increasing net sales, both are also experiencing the effects of inflation in the operating costs of working in the food industry. McDonalds has been refranchising consistently, while recently YUM! Brands has decided to follow the lead on this creative approach in avoiding the operating expenses impact on net income. By refranchising their company, it will help them achieve a more consistent net income, regardless of inflation. McDonalds’ hopes to continue franchising to expand their company, and while they do have the option to, YUM! Brands still has enormous opportunities for franchising with 97 percent of their restaurants in China still being company-­‐owned. Therefore, YUM! Brands may be able to utilize their greater franchising and expanding opportunities to financially expand past McDonald’s. It is important to note the relationship between YUM! Brands profit and debt. Their profit has been increasing, while their debt is decreasing. Their debt ratio has been on the decline due to a decrease in liabilities, but yet has consistent total assets. One can conclude that instead of having to take on more liabilities to buy more assets to increase profit, they have been able to master their efficiency in simply utilizing their available assets to generate more income. In the meantime, their Return on Equity’s impressive increase shows that they are making a smooth transition from utilizing less debt financing and beginning to create more profit off their available equity. This ability to create profit off of stockholder’s equity will also allow the company the privilege to either continue expanding or pay dividends which are both appealing to investors. On the other side of the spectrum, McDonald’s is maintaining their strategy of financing their company with long-­‐term debt. Their debt has held a long pattern of consistently increasing, and although it just recently began to plateau, their financial leverage is still continuing to increase. Meaning, they are still clearly holding a heavy reliance on debt to make profit. There is more risk investing in a company that holds onto an enormous amount of long-­‐term debt. This is also affecting the company’s liquidity in being able to pay back their current liabilities that include the current portions of long-­‐term debt. Their current and quick ratios have been decreasing because they have taken on even more liabilities, which may create more uncomfortable feelings of risk for investors. While YUM! Brands current and quick ratios are even lower than McDonald’s, the ratios have been increasing which implies a more promising future of being able to pay off their current liabilities. Although most of YUM! Brand’s current liabilities may have been acquired through the process of becoming a new company; they can expect to be paid off as they age. The majority of McDonald’s current liabilities include their long-­‐term business strategy of long-­‐term debt and can be expected to stay consistently high and possibly increasing. Therefore, YUM! Brands has a better chance of achieving more reliable liquidity over time, while McDonalds most likely will remain in the same position. Taking all of this into consideration, it would be recommended to invest into YUM! Brands. As a newer company still owning a lot of their restaurants, this allows them to have a much greater opportunity to continue expanding and refranchising. This promise of more freedom to expand their company and create higher profits in the future is appealing and possibly allows for a higher potential for investors to receive dividends or to have their money re-­‐invested into a successfully growing company. Furthermore, being able to create an increase in profit while taking on less debt, allows one’s investment to prosper in a more stable environment rather than in a risky one. While McDonald’s solid reputation of achievement is attractive, they are an older company beginning to reach their boundaries for growth and are less profitable personally for an investor since their financial focus is on managing their debt in relation to their profit. YUM! Brands is still young and shows massive amounts of potential in their profitability and ability to expand, as well as being personally rewarding to investors with such a high return on equity. YUM! Brands is a more promising and well-­‐rounded option for investment. Works Cited Casselman, Ben. "Number of the Week: More Jobs in 2011, But Still Not Enough." WSJ.com. Wall Street Journal, 31 Dec. 2011. Web. 02 Apr. 2012. <http://blogs.wsj.com/economics/2011/12/31/number-­‐of-­‐the-­‐week-­‐more-­‐
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